Neil Woodford favourite Provident Financial is now yielding 5.5%

Provident Financial Neil Woodford

It’s no secret that Neil Woodford is a big fan of Provident Financial (LON:PFG) (PFG.L).

The renowned fund manager has held a significant position in the sub-prime lender within his Equity Income Fund since inception, and a glance at the list of holdings in his new Income Focus Fund reveals that Provident is a top holding in that portfolio as well.

Provident shares have taken a battering recently, falling nearly 20% on news that restructuring in its home credit field organisation will leave a £40m shortfall in loan collections this year. A switch from self-employed debt collection agents to company employed ‘Customer Experience Managers’ has not gone as smoothly as anticipated and profits in the consumer credit division are now likely to be around £60m this year, down from £115m last year.

Since early May, Provident shares have fallen around 25% in value.

So is now the time to steer clear of Provident Financial or is a dividend opportunity on the cards?

Fixable problem?

It’s often said that profit warnings ‘come in threes’, meaning that investors shouldn’t rule out the possibility of further warnings down the line.

However, from what Provident have said, it does look like the restructuring issues are a temporary problem. The company has stated that the majority of new debt collection positions have been filled and that from July onwards, the rate of collections will “begin to normalise.” The board also stated that the switch to Customer Experience Managers should result in “improved collections and a more cost-efficient business.”

Importantly, Provident also said “there has been no change to the underlying credit quality of the home credit receivables book since the announcement of the reorganisation on 31 January 2017.

Dividend growth

With that in mind, I’m cautiously optimistic towards Provident right now.

The company has been an excellent dividend growth stock in recent years, increasing its dividend from 69p to 134.6p between 2011 and 2016, a compound annual growth rate (CAGR) of 14%.

With the share price falling back to 2,433p, Provident’s trailing yield has now been elevated to a high 5.5%, which is no doubt attractive in the current market.

However, it should be noted that dividend payout forecasts for this year have been downgraded considerably since the profit warning and analysts now expect growth of just 2.6% for FY2017. Growth of a more respectable 8.5% is forecast for FY2018.

It should also be noted that with analysts forecasting earnings per share of 161p this year, the expected dividend payout of 138.1p is only covered 1.17 times, which is not ideal. That doesn’t leave a lot of room for error, and if profitability falls more than expected, the company may struggle to pay a dividend of that size.

So the investment case from a dividend investing perspective certainly isn’t risk free. However, on a forward looking P/E ratio of 15.1, the stock’s valuation doesn’t look overly demanding, and as a result, I’m going to keep a close eye on Provident with a view to perhaps ‘averaging-in’ to the stock sometime soon.

Disclosure: Edward Sheldon, CFA has no position in Provident Financial. 

This article is provided for general information only and is not intended to be investment advice. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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